PORTFOLIO POINT: With no ongoing fees and a strong track record of outperforming the broader market, investors should be looking at Listed Investment Companies.
Ask any investor where they’ve parked their money, and almost without doubt you’ll be given a roll call of this year’s most popular managed funds along with a selection of the newest sensation, exchange-traded funds.
And with good reason. They deliver a vast array of investment opportunities, sometimes in markets and sectors that are difficult to access and across a broad portfolio that would be almost impossible for a small investor to amass with any kind of efficiency.
But there is another breed of investment vehicle, one that pre-dates high frequency trading, dark pools and even the internet. For that matter, some were around for generations before even the computer arrived.
They are called Listed Investment Companies and have been largely overlooked by investors in recent years in the rush for the new. But they are worth another look, if only for the simple fact that as a sector they generally outperform managed funds, delivering high yields and a greater degree of franking credits.
As a long-term investment vehicle, there is no denying their superior performance. A study last year by Morgan Stanley Smith Barney concluded that the top 10 LICs had outperformed the ASX by a convincing margin since 1979. The same LICs were slightly less volatile than the ASX 200.
"In summary, despite the neglected status of listed investment companies, it is quite notable they have outperformed the Australian stock market over a long period of time, displaying considerable alpha,” the report concluded.
“Over the medium term, this characteristic continues to be true, with underlying portfolios mostly outperforming the stock market despite a widening of discounts.”
The Morgan Stanley research showed that since 1979, Australian equity LICs have delivered a 144% higher return than the broad Australian equity market since 1979.
A more recent study by Bell Potter, from the June quarter of this year, compared LICs to managed funds. And the results were similar.
“The average outperformance of LICs, with a large and large-to-medium investment focus over similar managed funds for five and 10-year data, was 1.6% and 0.3% per annum respectively,” it found.
There are more than 60 of these vehicles listed on the Australian Securities Exchange. But the 10 biggest dominate, accounting for more than 75% of the market capitalisation of the sector.
They include names like Australian Foundation Investment Corporation, Argo Investments, Milton Corporation, Djerriwarrh, Australian United Investments, Wilson Asset Management, Contango, Whitefield and Carlton.
Six Listed Investment Companies you should know
Net Yield %
Large to medium
Large to medium
Medium to small
Medium to small
The superior performance of listed investment companies isn’t confined to Australia. In the US, they have consistently beaten mutual funds by a substantial margin since the end of the Second World War. And it could be argued that America’s most famous investor, Warren Buffett, essentially operates a LIC.
Clearly, there is more to this phenomenon than mere manager ability. One of the big differences between unlisted managed funds and listed investment companies is the structure.
Because they are listed on the stock market, listed investment companies essentially are closed end funds with a fixed amount of capital. What that means is that the money raised by the company, through issuing shares, can be used exclusively for investment. If investors want out, they simply sell their shares in the LIC on the stock market which does not alter the amount of money available for investment.
A managed fund or unit trust, in contrast, is open ended where the amount of money available to invest fluctuates, usually on a daily basis, as investors either buy or sell units in the fund.
That creates a fundamentally different investment philosophy and puts pressure on those managing unlisted funds. During a market downturn, an unlisted funds manager will be hit with demands for redemptions as investors retreat to cash. To meet those demands, the manager is forced to liquidate holdings often at a loss.
The converse is true in a rising market. A manager may be flooded with funds as investors chase returns. That essentially forces the manager to buy into a rising market and often to buy stocks that are clearly overvalued. Buying high and selling low is not the ideal formula for maximising returns.
LICs are not burdened by these constraints. If the company has $1 billion to invest, it has total control over its purchases and sales. If it requires more funds, it issues new shares.
Given the manager is never forced to trade, greater flexibility in terms of long-term investment decisions clearly exists within the confines of the LIC structure. Consider the incredible deals Warren Buffett executed during 2008 and early 2009.
In the midst of the financial crisis, Buffett’s Berskshire Hathaway group tipped $3 billion into financial giant GE, as confidence in the financier was shaken to the core. Buffet since has turned that into a $1.2 billion profit.
Goldman Sachs and Swiss Re, two other financials giants rocked by the crisis, also were the welcome recipients of Buffet investments at a time when no-one else would touch them. He’s since parlayed the Goldman investment into a $1.7 billion profit with another $1 billion coming from Swiss Re.
It is a good example of how a LIC can take advantage of a downturn. With cash flooding out of mutual funds, forcing them to sell and thereby accelerating the crash on Wall Street, Berkshire Hathaway had its stash of cash firmly in hand.
Then, of course, there are fees. It won’t come as any great surprise to discover that LICs operate under a much lower fee structure. While that has been greater returns flow through to the bottom line, it is also a factor in why LICs have been ignored as an investment vehicle.
Given they have eschewed the burgeoning “wealth industry” and not paid trailing commissions, they’ve generally been overlooked or deliberately ignored by financial planners seeking to enrich themselves.
With those kinds of commissions now banned, financial planners are expected to look more closely at these older-style investment vehicles. Another recent change in the law could also see a greater emphasis placed upon LICs.
In June 2010, the Corporations Act was changed to allow companies to pay dividends so long as they are solvent. Prior to this a dividend could only be paid if there was an accounting profit, even if the company had the cash flow, the cash and the franking credits.
During 2008, as asset values fell, LICs were unable to make distributions. That no longer will be the case, and many LICs can now plan a stream of dividends to be paid out over decades.
For the past few years, partly as a result of these now removed impediments and partly because the general market has been treading water, LICs have generally traded at below their net tangible asset value,
That has allowed canny investors essentially to buy a portfolio of high-yielding blue-chip stocks via a LIC at a 20% discount to the market price. But that persistent discount to net tangible assets has also been a drag on the sector.
For smaller LICs, that discount can become self-perpetuating. Reduced turnover and liquidity – because of the discount – justifies the discount, which then impacts on liquidity.
Asset cycles too can sway investor attitudes towards LICs. Despite the relative transparency of LICs, particularly when compared to managed funds, and the ease with which the value of a portfolio can be calculated, bear markets – or the threat of a bear market – tends to widen that discount.
As a rule, stock investors try to predict the future. So LIC stock prices can be hit harder during a downturn in anticipation the overall market may head lower.
For long-term investors, however, this delivers a sterling opportunity. Many of Australia’s largest LICs, such as AFIC – which began life as Were’s Investment Trust in 1928 – have amassed a dazzling array of blue-chip corporations.
Buying in at a discount during lean times is an easy way to ensure a decent yield. Given the recent run on the Australian market, however, and its resilience to recent falls on Wall Street since the US election, the discounts have narrowed.
AFIC, for instance, which until recently was trading at a small discount, now has a net tangible asset backing of $4.74 and a share price of $4.75, almost exactly in line with its portfolio.
As a sector, the LIC world is dominated by old and experienced hands. AFIC’s board, for example, includes names such as Bruce Teale, Don Argus, Terry Campbell and Ross Barker.
Even one of the newest LICs to hit the market, Mercantile Investments, has an old stager in control, Sir Ron Brierley, who has been joined by Gary Weiss and Ron Langley. Geoff Wilson of Wilson Asset Management had a hand in its formation.
Originally known as the India Equities Fund, Sir Ron took control after buying a stake and then selling his private share portfolio into the group. As an investor, Sir Ron has had a canny knack of picking winners in the past. But on each occasion, with BIL, IEL and GPG, the company’s focus changed to becoming an operating rather than an investment group with less than stellar results. This time, he’s told colleagues, he will stick to investing.
The old has become new again.